The recent unexpected aggressive appreciation of the local currency against the greenback, breaking the psychologically critical barrier of LE17.00/USD, raises several questions on the key drivers of this movement and the pound future.
In addition, it raises another question about the possibility of a CBE intervention in the market to prop up the pound, and the future of the local currency.
It was highly predicted that the Egyptian pound is to rebound and offset some of its post flotation losses against the dollar during 2019.
However, the Central Bank of Egypt’s (CBE) Governor Tarek Amer said in late January that the FX market is expected to witness more volatility compared to the relatively stagnant rates since mid-2017
After losing nearly 50% of its value against the greenback after the flotation of the local currency in 2016, the pound has been almost steadily rising at an average of LE 17.6 per dollar before appreciating sharply since the beginning of 2019, breaching the LE17/USD mark in May.
It seems that the government did not anticipate this surge as the draft budget for FY2019/2020 assumes an average exchange rate of LE 17.46 per the dollar. In the document, the Finance Ministry uses the average official exchange rate announced by the CBE during a two- week period from March 1 to March 15 to price of the budget items in next fiscal year.
One of the key factors for a stronger pound was the CBE’s decision to terminate its repatriation mechanism in December 2018, a step towards higher liberalization in the interbank and FX market.
The move was highly recommended by the IMF to boost exchange rate flexibility and deepen the interbank market. The repatriation mechanism aimed to reassure foreign investors they could get their dollars out of Egypt at any point.
Pharos Holding’s head of research Radwa el-Sweifysays, “This liberal move is one of the key reasons behind the volatility in the FX rate.” Around $2.4 billion was invested in Egypt’s Treasury bills (T-bills) in January 2019, according to the CBE data.
“This was not absorbed by the CBE, and this has driven the pound up, as foreign investors’ dollar injections into the market found their way solely into the banking system, thanks to the repatriation mechanism’s termination,” says Shuaa Securities’ senior economist Esraa Ahmed. The repatriation mechanism is an intervention tool that allows inflows and outflows to take place only through the interbank.
On escalating speculation that the CBE is backing the pound through state-owned banks, Ahmed tells Business Today Egypt, “The local currency was almost stable during the emerging markets’ turmoil during the past year… It only depreciated around 1%, creating a perception in the market that the CBE may be propping up the EGP one way or another…but we believe that the CBE has been intervening since mid-2017 to mid-2018, not to defend the pound, but to defend its competitiveness by keeping it cheap and stable enough to spur foreign inflows.”
Is the pickup sustainable?
While the pound’s appreciation was welcomed by some experts, who note the significance of tourism recovery and foreign inflows in Egypt treasuries as well as remittances from Egyptians living abroad, other are concerned about the sustainability of such a “rapid and sharp appreciation.” Shuaa’s Ahmed cited the fast appreciation to “temporary reasons,” adding that the movement of the pound in the short-term will be mostly linked to foreign holdings in Egyptian treasuries. Total foreign cash flows to Egypt have registered $24.765 billion from January to the present, reflecting investor confidence in the Egyptian economy, Reuters reported on May 16.
Boosted by foreign cash flows from several sources, the dollar exchange rate dropped more than 5% since January 2019. In April, the CBE governor said that foreign cash flows from different sources hit $130 billion since the float in November 2016.
However, Ahmed believes that the dollar will rebound to the high end of the LE 17 level, citing an anticipated pressure on the currency due to an inflationary wave ahead of the Eid season, which will be followed by a new round of energy subsidy cuts.
According to CBE data, Egypt’s foreign reserves recorded $44.218 billion by the end of April 2019, sufficient to cover eight months of commodity imports, while the global average is three months of commodity imports.
Banks operating in the Egyptian market determine the exchange rate according to the mechanism of supply and demand.
The medium and long-term outlook
Some analysts suggest that Egypt’s currency will not see a big dip in the foreseeable future, given several positive macroeconomic indicators, the anticipated inflation path and current account performance. “We do not see sharp depreciation in the medium-term,” says Shuaa’s Ahmed, citing significant improvements in the country’s external balances, compared to the pre-flotation situation. “Add to that how the pound is currently undervalued and the economy has not yet reached its potential in terms of exports and tourism.” Meanwhile, Ahmed warns of the “chronic issue of growing non-oil imports, especially that the bulk of imports cannot be tamed without hurting production activities.” However, she affirms that the positive outlook is also supported by “well-built reserves, with no worrisome short-term liabilities.”
On the competitiveness of Egypt treasuries, Ahmed concludes: “Egypt is expected to maintain a high appetite for debt instruments, securing decent inflows into the banking system as long the current global stance stays intact in the medium term.”
